Quanta Computer, Inc. v. LG Electronics, Inc.[1], presents facts at the intersection of two legal rules. On the one hand, patentees are free to impose restrictions, such as field-of-use restrictions, when they license others to manufacture their patented products.[2] Such restrictions can be permissible even if they would be antitrust violations outside the patent context.[3]On the other hand, a patentee cannot restrict the use of its patented products once they are sold, whether the sale is by the patentee itself or by a licensee.[4] This is the exhaustion, or first-sale, doctrine. [Background on Quanta v. LGE]

The Federal Circuit has caused the first of these rules to swallow the second, by allowing a patentee to convert any sale into a license by imposing some sort of restriction in the transfer. The restriction makes the transfer a “conditional sale,” and the Federal Circuit has held that the exhaustion doctrine applies only to “unconditional sales.”[5] It has applied this rule, moreover, despite the Supreme Court’s application of the exhaustion doctrine to conditional sales.[6]

The Federal Circuit’s approach allows patentees to transform a wide range of otherwise permissible conduct into patent infringement. All the patentee needs to do is forbid that conduct in its “conditional sale” arrangement. The Federal Circuit itself suggested in Mallinckrodt that this could allow patentees to eliminate the right of repair, and indeed other courts have applied the approach to allow patentees to eliminate not only the right of reuse/repair,[7] but also the right to resell patented products.[8] More generally, as the American Antitrust Institute argues in its amicus brief, the elimination of the exhaustion doctrine leads to considerable uncertainty, as downstream purchasers cannot know whether their use of the product is permissible unless they ensure that upstream sellers were in compliance with any license restrictions.[9]

It seems probable that the Supreme Court will reverse or at least vacate the Federal Circuit’s Quanta decision. It is likely to hold that sales of patented products exhaust the patentee’s patent rights, as the Solicitor General and other amici argue that it should. The patentee could still impose limitations on buyers’ uses of the products, but those limitations would be solely matters of contract. They could not be enforced through patent infringement actions, and they would be subject to antitrust law limitations.

But this raises two questions. First, will the Court define the difference between a sale and a license for this purpose? Quanta and the Solicitor General appear to take the position that the distinction should turn on the transfer of title. A problem with that approach is that it would give patentees considerable opportunity to use formal differences in the transaction to alter what should be substantive rules. (The Solicitor General may be unconcerned about this. It discusses with apparent approval Mitchell v. Hawley, 83 U.S. 544 (1872), where the patentee arguably forbad its manufacturing licensee from selling the patented inventions, granting only the right “to license to others the right to use the said machines.” The Court in Mitchell allowed an infringement suit against the downstream users, though the case is somewhat peculiar because the infringement arose after the original patent term had been extended, when the license terms extended only to the end of the original patent term.)

An alternative sale-license distinction might focus on what is being transferred by the patentee. As the district court argued in Mallinckrodt, one can read the Supreme Court’s decisions to allow restrictions on manufacturing licensees but not on ultimate purchasers. This echoes a distinction drawn in < ?xml:namespace prefix ="" st1 ns ="" "urn:schemas-microsoft-com:office:smarttags" />Europe, where the EC’s technology transfer block exemption applies to exempt from antitrust scrutiny certain “technology transfer agreements entered into between two undertakings permitting the production of contract products.”[10] Sales of the products after they are produced are governed by another block exemption.[11] Under this view, it is in the manufacture of the product that the patentee’s technology is first used, and its rights exhausted.

One effect of the exhaustion doctrine is to make price-discrimination more difficult for the patentee. For example, if the patentee would prefer to sell at different prices to different users, an inability to enforce its patent rights downstream would make it more difficult for the patentee to prevent arbitrage. But the Supreme Court has not hesitated to place other practical limits on price-discrimination by patentees, as in disallowing tying arrangements, which prevents metering through sales of the tied products (though only for patentees with market power). Moreover, even when its patent rights are exhausted, a patentee can enter into contracts forbidding resale for arbitrage, but it can only enforce those contracts through breach-of-contract actions, not through patent infringement suits.

The second question is whether the exhaustion rule applies if, as in Quanta v. LG, the product sold is only a component of the patented invention, in that it does not itself satisfy all the claim elements. The Supreme Court has said yes, at least in some circumstances: “[W]here one has sold an uncompleted article which, because it embodies essential features of his patented invention, is within the protection of his patent, and has destined the article to be finished by the purchaser in conformity to the patent, he has sold his invention so far as it is or may be embodied in that particular article.”[12] This rule recalls, though is perhaps somewhat broader than, the contributory infringement doctrine. That is, if this were the rule, the exhaustion doctrine would apply where there has been an authorized sale of a product that would contributorily infringe if its sale were unauthorized.

But the Univis Court followed the statement quoted above with another: “The reward [the patentee] has demanded and received is for the article and the invention which it embodies and which his vendee is to practice upon it.” Id. at 251. The question in Quanta v. LG can be viewed as turning on whether this second statement from Univis is one of law or of fact. If it is interpreted as one of law, then the Court is saying that the patentee must get its returns in the sale of the component invention. If the statement is one of fact, then the Court may just be relying on a view that the defendant in Univis had in fact gotten the return to which it was entitled in that first sale. In other cases with different facts, the patentee might be able to use patent law to enforce downstream restrictions despite the upstream sale of a component of the patented invention.

For example, one can imagine cases in which the maker of the component at issue, like Intel in Quanta v. LG, would have concerns about contributory infringement claims and therefore would seek a license from the patentee. That seems particularly plausible if the component at issue could be resold, so that even if its maker (Intel) ensured that its customers had licenses from the patentee, others to whom they might resell the component might not. It could make sense for the patentee to grant a license to the component maker in this situation, and make the license apply to downstream purchasers, rather than to enter into licenses with each of those downstream purchasers. But perhaps there could be circumstances in which the patentee would like to price-discriminate by use among the downstream purchasers, so that licenses at each level would be desirable.

It will be interesting to see how, or if, the Supreme Court will resolve this issue. As noted above, it could simply say that the patentee must get its profits from the component maker. This would promote certainty in the downstream product markets and be conceptually consistent with contributory infringement law. On the other hand, it would be somewhat odd to require that patentees deal with contributory infringers rather than direct infringers. Moreover, it would place limits on the ability of patentees to price-discriminate, though, as noted above, the Court might not view that as an obstacle. But one could also take the view that where the downstream applications are significantly different, so as to make separate downstream licenses desirable, there should be separate downstream patents, and that the upstream product then would not be “especially made or especially adapted for use in an infringement of [any one of] such patent[s].”[13]

The Court might simply choose not to address this issue. It could, for example, just correct the Federal Circuit’s approach to the exhaustion doctrine and then direct the Federal Circuit to address it.[14] That approach might look particularly attractive in that the LG-Intel license itself includes a provision that calls for application of the exhaustion doctrine: “Notwithstanding anything to the contrary contained in this Agreement, the parties agree that nothing herein shall in any way limit or alter the effect of patent exhaustion that would otherwise apply when a party hereto sells any of its Licensed Products.”

A final issue is that of LG’s method claims. The Federal Circuit held that “the sale of a device does not exhaust a patentee’s rights in its method claims.” As Quanta’s brief describes, this holding is inconsistent with Supreme Court decisions and even with other decisions by the Federal Circuit. Generally speaking, method claims that would be contributorily infringed by an unauthorized sale of a product should be exhausted by an authorized sale of the product. But if the method at issue goes beyond the normal use of the product at issue, so that the product arguably does not contributorily infringe the method patent, as suggested above for downstream product patents, it seems that exhaustion should not occur.

The Federal Circuit’s cases beginning with Mallinckrodt and continuing through Quanta have allowed patentees to use contract, or even simply unilateral notice, to eliminate the application of the exhaustion doctrine. By simply prohibiting certain conduct in their “license” agreements, patentees can under current Federal Circuit law transform what would be permissible conduct into patent infringement. The Supreme Court, however, said in Univis that “sale of [a patented article] exhausts the monopoly in that article and the patentee may not thereafter, by virtue of his patent, control the use or disposition of the article.” The Court’s forthcoming decision will likely reestablish that rule.

* Mark Patterson is a Professor of Law at Fordham University School of Law . His article on field-of-use licensing was recently published in the William & Mary Law Review. Mark R. Patterson, Contractual Expansion of the Scope of Patent Infringement Through Field-of-Use Licensing, 49 Wm. & Mary L. Rev. 157 (2007).

13 thoughts on “Reestablishing the Doctrine of Patent Exhaustion”

The “voluminous” articles and cases discussing “patent exhaustion” notwithstanding, I have always been intrigued by the absence in any I have reviewed of any attempt to relate situations such as this to the concept of “joint tortfeasors”, and particularly when one of them settles with the plaintiff. If memory serves me correctly, the release of one does not as a general rule release the other.

Several of these comments—particularly the last, very interesting one from Lucas Stelling—emphasize the issue of price-discrimination (i.e., selling to different buyers at different prices). I focused on this issue in my original posting, too. It is true, as I wrote there, that one objection to the exhaustion of patent rights upon an upstream sale is that patent law then could not be used to enforce downstream restrictions that aid in price-discrimination. I gave several responses to this objection in the original posting, but I would also like to respond to Mr. Stelling’s hypothetical.

Suppose, Mr. Stelling wrote, that A owns two patents, an upstream one for a polymer and a downstream one for bulletproof vests to which the patented polymer is very well suited. Suppose also that there are other non-infringing downstream uses for the polymer. Mr. Stelling suggested that, if exhaustion applied to both patents upon upstream sales of the polymer, then A would charge B, the polymer manufacturer, a higher price to reflect A’s desire to get returns on the vest patent, which, because of the exhaustion, it could not get downstream. Then, he wrote, B would pass that higher price on to all purchasers of the polymer, resulting in a price too low (in terms of allocative efficiency) to vest makers and too high to other users.

First, it is not clear why polymer sales would exhaust the patentee’s rights under the vest patent in this scenario. Because of the non-infringing uses for the polymer, the polymer would presumably not contributorily infringe the vest patent, and B would have no need for a license under the vest patent. A could license B under the polymer patent and, separately, the vest makers under the vest patent. There would then be no upstream exhaustion of A’s vest patent rights.

But maybe the non-infringing uses were not known at the time of the A-to-B license. In that case, as Mr. Stelling writes, A and B might indeed enter into a license to the vest patent, based on the contributory infringement risk. And that license might exhaust the vest patent rights (under Univis Lens, if the Supreme Court follows that decision in Quanta). Then A will be prevented from enforcing its vest patent rights even later, when there might be no contributory infringement because of the appearance of non-infringing uses for the polymer. But exhaustion actually seems to be the right result here. In its license from A, B has already paid for the infringement risk. Therefore, it is B, not A, that should profit from the vest makers’ use of the vest technology. Exhaustion would make that possible: Because the vest makers would not have to pay A for the vest patent rights, B could extract the value of those rights in its sales of the polymer. And, again, this is not unfair to A, because A would already have been paid for those rights by B.

Moreover, B would presumably price-discriminate. That is, B would presumably charge a higher price to vest makers (through its polymer sales) and lower prices to others, just as Mr. Stelling says that A would like to do. In fact, B is more likely to be able to price-discriminate effectively among its customers than A would be, because A would have no relationship with the non-infringing buyers.

Arbitrage (and perhaps the Robinson-Patman Act) could present obstacles to price-discrimination in this situation, in the absence of possible infringement liability. That is, the non-infringing buyers might resell the polymer, which they get at a low price, to the vest makers, who pay a higher price. But these problems exist in the absence of exhaustion of the vest patent, too, because the sale of the polymer will certainly exhaust the polymer patent rights (unless the Supreme Court eliminates the exhaustion doctrine entirely). And B, the polymer maker, is probably in a better position to use contractual and non-contractual approaches to preventing arbitrage, because it is the one in the supplier-buyer relationship with the downstream buyers.

To sum up, if there is no contributory infringement risk, then there is no need for the patentee A to license B under the downstream vest patent. And if there is a contributory infringement risk, it may make sense for A to license B, but then A gets paid for its downstream vest patent in its license with B. Subsequent downstream enforcement of the vest patent would be opportunistic double-dipping by the patentee.

As to Mr. Slonecker’s post, I believe he is correct that the devil is in the details in this one. I had an opportunity to attend a luncheon about this case at McKenna Long & Aldrich given by Mr. Song Jung, who had a hand in an Amicus on the side of respondents. A central issue explained to us was that Intel never sold a device that read on the patent in issue.

It was explained, that the purpose of the license agreement at issue between LG and Intel was a form of risk management on the part of Intel. They weren’t ~really~ buying rights to make, use, and especially sell the technology claimed, instead they were buying their way out of a potential contributory infringement suit based on the use of their “sub-combination” chips in potentially infringing downstream customer uses. If I remember correctly, a requirement of the license was to notify purchasers of their chipsets that downstream use in certain devices may be covered by patents owned by LG. (This aspect vitiates the “we had no way of knowing” arguments).

It’s also worth noting: we were told that Intel actually obtained a license to make, use and sell the claimed computer technology of the patent in issue, but that they did not in fact manufacture or sell covered computers. They only sold a subcomponent used in the downstream computer — the chips. Quantas argument is essentially that Intel’s right to make use and sell the entire computer was extinguished by the sale of the chip.

I think this raise an issue based on “no non-infringing use.” Hypothetically, if you have the right to make/use/sell patented technology — in this case the computer; and you make and sell a component of it — a chip that can only be used with said patented computer, and in no other, then you’ve essentially sold the essence of the invention and parties and market participants can reasonably expect the only use for the product sold is in a device that reads on the claims of the patent. In that case, the “no non-infringing use” should be enough to create a presumption that the first sale doctrine applies because the downstream purchasers expect to get the full value of the patented technology, and the seller would essentially be selling it to them.

On the other hand, if there are other alternative non-infringing uses for the sub-component, which I believe is the case here — Intel sold chips that are/were useable in devices not covered by the LG computer patent claims (or in Patent Office lingo, had separate utility) — then first sale should not apply to the sale from Intel to Quantas based on the licensing agreement between LG and Intel. The issue is foreseeability: none of the parties can known ahead of time whether first sale doctrine and patent exhaustion will occurs at the upstream sale (Intel->customer) until all downstream uses are actually carried.
Hypothetically, lets say Company A owns a patent on a polymer with fantastic strength, which is optimally and notoriously suited for making bullet-proof vests, which Company A also happen to own a patent on. Suppose they license to Company B who gets a license primarily for the manufacture of the polymer, and also licenses the vests because its reasonable to foresee that customers _might_ use the polymer for the vest-patent infringing purpose. Basically, Comp B hedges their risk that their downstream customers will infringe, potentially subjecting Company B to expensive litigation based on foreseeable contributory infringement. But persons knowledgeable in the art would also instantly recognize the use of the polymer for creating parachutes, guy-wires, or medical prosthetic devices — all non-infringing alternative for which there is market demand.
If first sale doctrine of the vest patent applies as to the sale of polymer from Company B to market participants, then its reasonable to assume that Company A will demand a larger royalty upfront for the A->B license because it’s the only chance A has to capture value from the downstream sale of the polymer when its used in products that read on the vest claim. B’s options are to internalize this cost, or, more likely, pass it on and “socialize” it to all market participants who purchase the polymer whether for the vest use or not. The cost for the vests is artificially lowered, and the cost for all other non-infringing uses is artificially raised, thereby lowering demand for them. The result is that the allocation of resources is not idea because the vest maker is not paying the true cost for using the patented vest technology.
In the alternative, if the first sale doctrine of the vest patent does not apply as to the sale of the polymer from Company B to market participants because there are non-infringing alternatives then costs and benefits are allocated efficiently. Lets also assume that Company B notifies downstream purchasers that use of the polymer in vests might infringe A’s patent (this eliminates most arguments of transactional inefficiencies based on asymmetric factual knowledge). In this case, Company B’s cost for the license will reflect the true value that they, Company B, are deriving from it. They are licensing the right to manufacture the polymer, and are hedging their risk against foreseeable contributory infringement only; they won’t be extinguishing A’s rights as to downstream users, and so its reasonable to assume A would expect less upfront in the licensing agreement. There are opportunities later on for A to capture the full value of the patented vest technology. The result of the lower upfront cost is that each downstream user will pay the appropriate cost for the use they make of the polymer, thereby allocating resources more efficiently. That is, those that choose non-infringing alternatives can use the polymer freely once bought; and those that intend to make the vests are on notice that their use may infringe company A’s patent, and that they should bargain for that right or suffer the consequences.

One fallback position that was discussed at the luncheon was that the Supreme Court may choose to sidestep these issues as largely academic, and opt for a semantic argument. Basically that the whole argument is moot if instead of attempting to provide a limited/conditional license to Intel, LG and Intel just bargained away Intel’s personal liability for any contributory infringement.
This case deserves serious discussion. Lets hear some more.

Having read the “briefs” by Petitioner, Respondent, Amici, and the DOJ, I was struck by the lack of emphasis on the simple fact that none of the chipsets Intel manufactures and sells apparently infringe the various patents held by LG. From what I gather an act of infringement occurs at such point in time as a computer OEM combines chipsets purchased from Intel and others (perhaps like AMD) with other components contained in a computer. It seems reasonable to assume that Intel and other similarly situatued chipset manufacturers can be characterized under the circumstances as contributory infringers, and that OEM manufacturers of computers using chipsets purchased from Intel and other manufacturers can be characterized as direct infringers.

Undoubtedly, the value of LG’s patents resides in the manufacture of computers, and being a computer manufacturer itself (laptops), I can well understand why LG is not exactly keen on having competitiors manufacture products purportedly within the scope of LG’s patents. I can also well understand why Intel would want to make any contributory infringement issue go away so that it could go on with its business of selling chipsets. What I do have difficulty understanding, however, is the logic behind the argument that the Doctrine of Patent Exhaustion leaves LG out in the cold vis a vis those who allegedly engage in acts of direct infringement. LG certainly has not authorized Intel to manufacture and sell computers ostensibly within the scope of LG’s patents. Were this the case then patent exhaustion would appear to be a relevant issue; but that is not the case presented here. Is this really a patent exhaustion case, or would it be more accurate to say that as a practical matter an alternate rule/doctrine should apply, and what should that alternate rule/doctrine be?

Research tools are a little esoteric. No doubt they are important to some, but the more common situation is that of using pattern parts to fix all manner of end user devices, to wit, the family car. Patent exhaustion had better be upheld, or Detroit will be able to charge what it likes whenever a part breaks on the cars we all use to get to our law offices, etc.

Dennis, point well taken. Although this case does not speak (where I believe Integra v Merck does) to unpatented research tools that are distributed to companies for product development, the method of use for which are patented by another (e.g., genetic vectors, phage display libraries, mouse models). Conversely, the Invitrogens of the world would be precluded from collecting as infringement remedies the dollar value of “reach through royalties” on the sales of a final product made using the research material. Reach through royalties are oft negotiated in private sector research tool deals (e.g., for libraries) to circumvent the default patent exhaustion position. CAVEAT EMPTOR!!! Your $100 research reagent may contractually bind you into $100,000 in reach through royalties if you don’t read your purchasing agreements carefully or at least try and negotiate these out.

5

yet another anonymous but not that anonymous or that other anonymoussays:

“Imagine if consumers were prohibited from using car engines for anything other than powerwing the car, or were prohibited from renting DVD movies that were licensed for sale. That, in my view, would be government intrusion at its highest, would in no way further the objectives of the patent/copyright clause of the Constitution, and ultimately devalue the initial sale of a copyrighted work or license of a patent while the copyright or patent holder holds out for nickels and dimes on any innovative secondary uses…”

Imagine, if you will, a software license… or better yet, an “End User License Agreement” neatly tucked away inside of the opened-and-therefore-non-returnable copy of Acme Widget that you’ve purchased at your local retailer.

Imagine, if you will, a law… or better yet a law known as the Digital Millennium Copyright Act, whereby you are prohibited from watching video of old baseball games that you purchased from MLB because MLB decided to abandon its old DRM authentication system in favor of a new one. (link to arstechnica.com)

Do not raise the state of copyright law as an argument for weakening the ways in which patent owners can sell or license their property. The argument verges on the disingenuous.

What Shahid finds strange is commonplace in most life experience. If I buy a Ford F-150 pick-up truck and modify it to serve as the engine for my flour mill, or for use as a tow-truck, neither Ford nor any of the patent-holders whose inventions are embodied in the F-150 can expect a penny more. This has been the norm (and codified since 1909) in copyright law. If the copyright owner sells a book or a movie on DVD, it is entitled to not a penny more, even if the book is used as a door-stop or fuel for the fire, or the DVD rented or loaned to a few thousand people — or used as a coaster. Not strange at all. Indeed, the owner of the patent, as does the owner of copyright, is able to command a better price for the initial sale or license precisely because the customer is free to put it to other uses.

Imagine if consumers were prohibited from using car engines for anything other than powerwing the car, or were prohibited from renting DVD movies that were licensed for sale. That, in my view, would be government intrusion at its highest, would in no way further the objectives of the patent/copyright clause of the Constitution, and ultimately devalue the initial sale of a copyrighted work or license of a patent while the copyright or patent holder holds out for nickels and dimes on any innovative secondary uses, fcomplete with high friction of obtaining licenses for those uses. (Well, Joe, I know your grandaddy always hooked up the truck engine to the flour mill, but this is a new day. You now have to find all those people whose patents are involved in taht engine and get a license from them to do it.)

This synopsis pays little attention to the facts and holding of General Talking Pictures, also a Supreme Court case, which was largely the basis for the Mallincrodt decision.

On a broad level, if the SCOTUS overturns Quanta, it will result in patentees who hold patents on new compositions of matter being barred from getting effective patent protection on various end uses of that composition of matter, while permitting their customers to do so. Strange.